Monthly Archives: May 2015

According to a recent article in PLANSPONSOR® (May 6, 2015), the National Conference on Public Employee Retirement Systems (NCPERS) has developed a 10-point voluntary “Code of Conduct” for service providers to public employee pension programs.

According to the article, the plan requires service providers to:

Act in a professional and ethical manner at all times in dealings with public plan clients;

Act for the benefit of public plan clients;

Act with independence and objectivity;

Fully disclose to public plan clients conflicts of interest that arise that may impair the ability to act independently or objectively;

Act with reasonable care, skill, competence, and diligence when engaging in professional activities;

Communicate with public plan clients in a timely and accurate manner;

Uphold the applicable law, rules, and regulations governing their sector and profession;

Fully disclose to public plan clients all fees and charged for the products or services provided to said client;

Not advocate for the diminishment of public defined benefit plans, and;

Fully disclose all contributions made to entities enumerated in Schedule A that advocate for the diminishment of public defined benefit plans.

Most public and private pension professionals would certainly agree that most of the points above should be expected of any professional entity operating in the public pension arena. And it should not apply just to “service providers”. It should also apply to the conduct of public retirement systems as well. Perhaps that was the intention of NCPERS, but if so, it doesn’t say that. To make it clear that both parties are bound by this conduct, some modifications are in order:

Public pension systems also have an obligation to fully disclose the facts, including a more realistic measurement of potential costs to all stakeholders. The public deserves to know what the implications are if the assumed rate of return for the public retirement system fails to materialize. What would be the impact on the system and on stakeholders? A study by Cheiron for a state retirement system in 2013 calculated that there was only a 40% chance the retirement system would achieve it’s assumed rate of return of 7.5% over the next 20 years. Studies like that need to be conducted by every public retirement system, and the results need to be shared with all stakeholders. Public retirement systems also need to act with “independence and objectivity” in developing alternative plans of action if the assumptions turn out to be wrong. And, those alternatives should be openly debated by all stakeholders. In January of 2014, The Nelson A. Rockefeller Institute of Government issued a report titled “Strengthening the Security of Public Sector Defined Benefit Plans”. The report makes a compelling argument that the proper rate for valuing pension liabilities on financial statements is separate from the question of what pension funds assume they will earn on their investments. This report, and others like it argue that the public sector is not doing all it could to fairly and objectively estimate the potential long-term costs of their system. Some retirement systems deal with this better than others, of course. However, there remains a prevailing “circle the wagons” mentality in too many public systems where there is reluctance to deal openly and honestly with stakeholders about the potential cost of funding current benefit obligations.

This brings to the last two points in the “Code of Conduct”. Service providers must:

Not advocate for the diminishment of public defined benefit plans, and;

Fully disclose all contributions made to entities enumerated in Schedule A that advocate for the diminishment of public defined benefit plans.

Any public entity that relies entirely on taxpayer funds should not try to stifle free speech. Penalizing taxpayers and other stakeholders for engaging in a public debate is just bad government. There is never an acceptable excuse to limit or restrict free speech, yet this is what these two points seem to imply. It could be argued that, in some jurisdictions, it may even be illegal to use a public contract for services to muzzle any discussion about a public entity that could be deemed “diminishing”[1]. I’m not a lawyer, so I will leave that discussion to others.

This is not the first time these types of provisions have been used by public retirement systems and/or boards that oversee public pensions. At least one state government has a clause in their contract with their service provider that prohibits them from saying anything negative about the defined benefit plan, or engaging in any public discussion that may appear threatening to the policies of the Board.

A city in California has a clause in their contract that permits them to fire their vendor if any staff member (including employees who live in that city) speak to the city council about any issues they have with plan governance. In other words, don’t bring any possible missteps to the attention of the elected officials on the city council. If you do, you’re fired and not eligible to bid on the plan again. While it is unlikely that any court would agree that a public entity can prohibit taxpayers from speaking with their public officials, the vendor (in this case) signed the agreement for fear of losing the contract.

There are other examples besides those above. The point that is lost on so many public retirement systems is that any public discussion of retirement plans, funding alternatives, benefits, and yes, even alternative plan designs, is a healthy exercise. Many individuals, companies, and research organizations are, in fact, trying to encourage steps that would shore up these systems and make them more sustainable in the long-term. Not everyone who shares an opinion is an enemy lurking around the corner. When any pubic entity sees public commentary as an enemy, it diminishes the ability to craft creative solutions to pension system problems.

It is this type of behavior, and the failure to engage in honest and objective discussions of defined benefit plans that is feeding taxpayer angst about public sector pension plans. Voters in cities like San Diego and San Jose may have felt differently about their ballot initiatives if they had confidence in the integrity, objectivity and cost assumptions used by their public pension officials.

Entities that are fully taxpayer supported (by individual and corporate taxpayers alike) are only creating suspicion and mistrust when a code of conduct is “one-sided” and punishes any free speech the system finds “diminishing” (however defined) to the system.

Gregory Seller

Gregory Seller Consulting, LLC

Gregg is an independent consultant specializing in public and private pension advocacy, plan architecture and design, and thought leadership for public pension policy. His practice is fostering debate on improving public and private pensions in the United States, and on the more efficient delivery of secure pension benefits to plan participants.

For more information on this topic and related issues in public plan governance, please go to: www.gregoryseller.com

Provided for information only and is not legal or investment advice. Plan sponsors should seek their own legal counsel on theses and other matters regarding their fiduciary responsibility.

[1] There are several definitions for “diminishment”. One of them is “The act of reducing in size, quantity or quality.” Merriam Webster® defines it as (among others) “To become or to cause (something) to be less in size, importance, etc.”

In January of 2014, The Nelson A. Rockefeller Institute of Government issued a report titled “Strengthening the Security of Public Sector Defined Benefit Plans”.[1]

The report makes a compelling argument that the proper rate for valuing pension liabilities on financial statements is separate from the question of what pension funds assume they will earn on their investments.

A More Accurate Estimate of Ultimate Cost

Rather than valuing future liabilities based on the “assumed rate of return” declared by the pension system, the report says a fairer picture of the true cost of the plan for all stakeholders would be a discount rate tied to some instrument like high quality municipal bond rates.

It is important to emphasize that this study, and others like it, aren’t opposed to retirement systems setting target or “assumed” rates of future return for investment purposes. The important distinction is that, for financial statements, it would be far more reasonable to use a discount rate from actual market instruments, instead of some “assumed” long term rate in the future.

Nothing to be Afraid of

Unfortunately, many public retirement systems have taken a negative view of this proposal. The fear seems to be that taxpayers and other stakeholders will be shocked by what they see as the potential long -term cost of the plan, when measured more conservatively. In that regard, the study does not argue for valuing such plans on a “risk free” rate of return, as have some other similar studies. Instead, it advocates for the use of a discount rate on high quality municipal bonds, or something similar.

Administrators of public retirement systems should not fear using such a measurement. In actuality, it would help the longer- term health of these plans if there was a more frank and realistic discussion of what the costs of these plans could be, particularly if they are not managed prudently. It would also make politicians less likely to skip or reduce required pension payments since it would highlight the impacts of under-funding more significantly.

Stakeholders deserve a more honest assessment of what these plans will likely cost. Shareholders in a corporation may vote with their feet by selling shares in a company that is not properly managing its pension liabilities. Taxpayers, on the other hand, can’t opt to do the same thing unless they pick up and move to another locality, which can be a costly and impractical proposition.

Being Well Informed is Better Than Ignorance

Since as much as 70% of the benefits from a retirement system can be derived from investment returns, it is of course important to maximize earnings as prudently as possible. However, it is equally important to minimize risk, and to evaluate those risks in the most realistic fashion. Keeping stakeholders in the dark about the true ultimate costs of these plans will only increase the negative feelings and apprehension that has been building against public sector defined benefit plans for the past decade. A more honest and forthright estimate of potential costs will serve to benefit public employees in a number of ways, including making required funding payments and avoiding political tampering with benefits and cost estimates. In the long run, that will not only bolster the financial security of these plans, but also make them more respected for being prudently managed.

I encourage you to read the full report at www.rockinst.org.

Gregory Seller Consulting, LLC

All rights reserved. May not be reprinted in whole or in part without written permission. Provided for information only and is not legal or investment advice. Plan sponsors should seek their own legal and investment advice on this issue.

[1] The Nelson A. Rockefeller Institute of Government is the public policy research arm of the State University of New York. The full report may be accessed at www.rockinst.org